Can An Old Tax Tool Teach Us New Tricks?

Fiscal equalization offers three lessons in local tax policy and regional prosperity.

Endowed Professor of Public Finance and Civic Engagement at the Daniel J. Evans School of Public Policy & Governance at the University of Washington

In 1971, the famously well-mannered Midwesterners of the greater Twin Cities region earned a reputation as brassy fiscal outlaws. How? They agreed to share their local tax base.

Four decades later, their grand experiment and a few others like it have taught us some important lessons about the links between local tax policy and regional prosperity. Those lessons are especially relevant today: Many voters expect their local governments to tackle disparities in everything from housing, policing and human rights to mental health, education and jobs. These were once federal and state issues, but with no clear guidance from Congress or statehouses, localities have taken these pressing matters into their own hands.

The Minnesota Fiscal Disparities Program grew out of a series of nasty annexation fights in the late 1960s. As the region grew, cities tried to protect their tax bases by grabbing whatever land they could find. This led to a zero-sum game, where cities and school districts grew their tax bases at the expense of their neighbors. A few wealthy jurisdictions played this game well, but the rest were left behind.

So in 1971 the state legislature required local governments in the seven-county Twin Cities region to share with each other a portion of the annual growth in their commercial and industrial property taxes. The goal, according to the program’s legislative champions, was to ensure to a business locating in the region that “one community was the same as every other.”

This was not entirely new. Many county governments share a portion of their sales taxes with cities. That sharing usually happens on a per capita basis. But the Fiscal Disparities Program was different. It distributed the shared revenues according to local governments’ ability to pay. Jurisdictions with less “fiscal capacity” receive a larger portion of the shared revenues, and vice versa. According to the League of Minnesota Cities, in 2016 the program shared $373 million. That’s about 10 percent of the regional tax base.

Several regions, including the Meadowlands area of Northern New Jersey; Greater Dayton, Ohio; Louisville-Jefferson County, Ky.; and Greater Portland, Ore., have created similar “fiscal equalization” programs. Many of these projects are now decades old. So is this old-school tool up to today’s challenges?

Existing programs have taught us three lessons that’ll help answer that quesion.

Lesson 1: It smooths growth throughout a region. Studies of the Fiscal Disparities Program have shown the cities with the strongest tax bases have three times as much fiscal capacity as those with the weakest tax bases. But without the program, that difference would be 10 to 1. The Dayton program allowed the Miami Valley region to pursue economic development projects that require large swaths of tax-exempt land, such as professional sports stadiums, regional parks and museums. Cities don’t typically pursue these projects because they don’t want to give up precious tax base. Regional shared revenues make those projects possible.

Lesson 2: It’s no picnic. Wealthier jurisdictions have good reason to oppose equalization. They can become perennial “donors” that give up substantial tax base with little tangible reward. Equalization also largely ignores the actual cost to deliver services. For these and many other reasons, critics have routinely challenged these programs in court. Equalization formulas and other program details have changed in response. In short, equalization is a journey, not a destination.

Lesson 3: It leads to unexpected cooperation. In 1985, Louisville and Jefferson County established their own version of equalization based on a local income/employment tax. That program worked so well that it was one of the main reasons the two merged entirely in 2003. Once taxpayers saw what a basic level of public services throughout the region looks like, they saw no need for separate city and county governments.

Meanwhile, the Meadowlands program allowed several governments to preserve open space they would have otherwise offered up for development.

Local fiscal equalization is the exception, not the norm. But in a world where cities and regions must tackle daunting challenges, it might be just the fiscal tool that many communities need.